Tuesday, 15 March 2016

The Great OK: U.S. economy muddles along

U.S. interest rates remain extremely low and that can only mean one thing: The economy isn’t growing fast enough to justify making it more expensive to borrow.

The Federal Reserve is expected to stand still and leave interest rates unchanged after bank VIPs meet this week. Nor are any of the economic reports on a busy calendar likely to give them any reason to act differently.

Retail sales in February, for example, are forecast to turn negative. A pair of surveys of American manufacturers are likely to remain under water. And inflation shows little sign it’s about to soar — what would be a sure sign of an economy catching fire.

Instead the economy has caught a bit of a chill. Growth softened to 1% in the final three months of 2015 and the new year has gotten off to a plodding start. The U.S. probably will grow faster in the first quarter, but economists are forecasting a mild 2.3% advance in gross domestic product.

Chief economist Robert Dye of Comerica Bank calls the current era “The Great OK.”

Yes, the economy is growing at a 2% pace. And yes, the economy is producing a healthy 200,000-plus jobs a month, which has knocked the unemployment rate down to an eight-year low of at 4.9%.

Yet the U.S., seven years into a recovery, is also experiencing the weakest rebound since World War II. The economy has expanded historically at a 3.3% pace, but the U.S. hasn’t topped 3% since 2005. Missing from the current expansion has been the explosive 4%-plus gains in GDP that typically happen early on.

“Even though things are unquestionably better today than they were five years ago, the economy is not great,” said Stephen Stanley, chief economist at Amherst Pierpont Securities.

Part of what’s holding the economy back is slow wage growth and stagnant household incomes.

The falling unemployment rate has forced some companies to raise wages to attract workers, but the gains are not widespread. A study by Deutsche Bank found that only about one-third of industries have been forced to raise wages by at least 3%.

Most workers are only getting a bump in pay of 2% or less — far less than the typical wage gain in a strong economy. And millions of Americans are still stuck in part-time jobs or can’t find full time work. Many have even dropped out of the labor force entirely.

Businesses, for their part, find it hard to raise prices and a recent survey of small businesses show that most are swallowing higher labor costs. Lower profits in turn leave them little incentive to boost investment, the key to stronger economy.

The difficulty faced by most companies in raising prices also helps explain why inflation is still well below the 2% level the Fed believes would be healthier for the economy. It’s not just tumbling prices of oil and other imported goods that are keeping inflation low.

Fed officials insist inflation will rise gradually from current low levels and to some extend that’s already happening. Rising costs of housing and medical care are main culprits.

If that keeps up, the central bank is expected to raise interest rates at least once this year, perhaps as early as summer. But just three months ago the Fed was signaling as many four interest-rate hikes in 2016.

Call it, as Dye does, The Great OK. The U.S. is creating enough jobs and growth to warrant the occasional increase in interest rates. But 2% or so growth is perhaps the best the economy can do.